Wednesday, January 7, 2015

Coop Finance

This is the season for blog posts about What I Learned at the ASSA Meetings. Maybe the single most important takeaway for me occurred in the URPE panel on worker cooperatives. Chris Gunn gave a report on Equal Exchange, which is structured as a worker coop, and how it is financing its relatively rapid expansion. This definitely set my neurons firing, and I’d like to share some thoughts here.

First, however, a word of background. Coop finance is one of biggest and oldest controversies in the field. There are two issues actually, startup finance and finance for expansion. Why it matters: on the one side, the whole point of cooperation is to democratically vest control of the enterprise in the workforce, and ownership is a principal vehicle (though not the only one). On the other, one of the chronic weaknesses of worker coops is undercapitalization, which has made their share of the overall economy smaller than it would otherwise have been. Those who emphasize democracy want to rely primarily on member capital contributions and retained earnings; those who want more rapid growth in an increasingly competitive world look to debt. Each side thinks the other is a threat to the future of the movement. (Slightly exaggerated.)

Meanwhile, another classic issue is asset diversification. A longstanding criticism of worker coops is that they force members to hold assets whose value moves in tandem with their earnings as workers. In particular, if a coop fails, workers lose their wages and their investments in the firm. The Mondragon coop conglomerate went a long way toward solving that problem by making a diversified portfolio of firms the unit of finance, while each member firm is (mostly) controlled by its own workforce in the conventional coop manner. But the problem with the Mondragon model is that it is difficult to replicate: it works because the system is actually large and diversified, with many producer coops supported by a bank, a university, a social insurance system, etc. Can you, the small, struggling isolated coop far from the Basque world, get there from here?

Enter the Equal Exchange solution. This coop has financed itself by issuing preferred (nonvoting) stock. It’s different from debt because, as equity, it can be encumbered in ways that debt can’t. Specifically, investors in this stock can’t redeem within five years without accepting a significant penalty, and the shares can’t be sold to third parties—no secondary market. They carry a fixed nominal interest rate at a fixed term. So who buys this stuff? Equal Exchange markets primarily to its own partners, such as retailers like food coops. They are successful at this and have financed most of their expansion through this vehicle.

So here are my thoughts:

1. This is an ideal solution to the debt financing conundrum. Preferred stock approximates debt from a financial perspective, but it yields far less influence. Maybe both sides in the more democracy versus more capital debate can be happy.

2. Cross-ownership via preferred stock can be a vehicle for dispersed coops to replicate the Mondragon model, at least on a financial level. You might think it’s a disadvantage to not have the collective goods that Mondragon provides its member firms, and you would be right, but this also means you don’t have to set up the large, costly superstructure to enjoy the advantages of asset diversification. Meanwhile, it raises new questions about how much of the member’s contribution should be in the form of a voting share in their own firm and how much in the firm’s preferred stock investment fund, balancing incentive against diversification interests. That’s a great thesis project for someone. (I’m assuming that some portion of a coop’s preferred stock investments are financed directly by members, some by retained earnings, and some by issuance of their own preferred stock. A lot of the cross-ownership is simply a swap.)

3. Of course, a portfolio should not consist solely of debt-like, lower-risk, lower-return investments. From a finance point of view, coop equity should include a component that has higher returns over time but experiences more earnings fluctuation. The obvious answer is a venture capital fund to which coops could contribute and which would be managed by a Mondragon-like second-level entity. (There would not need to be much organizational structure for this; a representative supervisory board plus a watchdog unit should be enough.) Such a fund would address the other finance issue, startups, by supporting new coop formation. Again, there is a portfolio balance problem to solve: how much for the preferred stock fund and how much for venture capital?

Veterans of debates over labor-managed economies (many with Cornell degrees) will know I have bypassed a number of issues in this post, but my goal is not to devise a complete solution, just to put some general ideas on the table. And thanks to Chris for telling the Equal Exchange story—and for his decades of service to the cause of worker-managed enterprises.